INVESTING

When activist hedge funds come knocking, answer with zero-based budgeting

Karen Clarke, Area Vice President EMEA at Anaplan

What do companies like Unilever, Nestlé, Honeywell, Mondelēz International, Akzo Nobel, Procter & Gamble, DowDuPont, Danone, BHP and General Motors have in common? They’ve all been targeted by activist investors, and forced to spend precious resources defending, rather than running, their businesses.

In Europe we are not very familiar with this type of investor. A few exist in London, but most are located in the United States, in New York or Connecticut. Their usual modus operandi is to quietly acquire a significant portion (up to 3%) of a public company, alert existing management of its holdings, and call for changes in company governance and allocation of resources.  For example, they may demand a couple of seats on the board, the ouster of the CEO, or the payment of an extra dividend financed by large cost reductions or an increase in long-term debt. They often propose splitting up the company into several entities or selling it entirely. They may even attempt to derail a long-planned merger or acquisition and force the company to follow another path.

Activist investors are not a trivial presence in today’s markets. According to a recent study by Lazard, 124 companies were targeted by activist hedge funds in the first nine months of 2017. To achieve their activist ends, the study found, hedge funds spent $45 billion dollars in from January to September 2017, more than double their 2016 spending. Activist hedge funds are no longer just focused on companies in the United States; European and Asian companies are increasingly their targets, and they are targeting bigger and bigger companies.

For company management, the arrival of an activist hedge fund is rarely good news. On the surface, the funds’ requests for better returns seems straightforward: cut costs to deliver more short-term profit and greater returns. But often this directive clashes with existing management’s commendable and thoroughly considered desire to keep a company on its planned course.

Is it possible to reconcile the two positions? To cut costs intelligently while at the same time preserving investments for growth? The answer is yes, and many companies do so with the help of zero-based budgeting (ZBB). This budgeting method has existed since the 1970s but has been little-used until recently. What’s changed: Cloud-based planning and budgeting solutions have made implementing ZBB more achievable.

ZBB consists of justifying every possible expense, in microscopic detail, before incurring any expenditure. It’s not just about shaving off costs; it’s a management philosophy dictating that unnecessary expenditures are cut and investments that support company growth are maintained or even increased.

The results of using ZBB can be spectacular. In the United States, food manufacturer Kellogg Company saved over $150 million in 2016 thanks to ZBB, and has declared its intention to achieve $450 – 500 million in savings between 2017 and 2018. In Europe, one company pared its fleet of 3,000 mobile phones down to 1,800 when ZBB revealed how many of the phones were actually activated per year. Given the price of a smartphone, the company saved close to $1 million they could distribute as a dividend or reinvest in marketing.

Other large companies have followed these examples, and thanks to ZBB they are prepared to demonstrate exactly how they use their resources if an activist hedge fund came knocking at their door. Are you ready for that knock? Because it’s imperative for you and your company to know how your budget would measure up if an activist investor came calling.

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